If you've been considering investing or expanding your portfolio, you've likely come to a fork in the road: you can either take the value investing or growth investing route. These are the two main types of stocks, primarily chosen based on investing style. Although you'll find that people often consider them to be either/or options, it's essential to consider the advantage of diversification.
This article discusses both growth and value investing, providing examples for each so you can see how they work. It explains the difference between growth investing and value investing, and you'll learn how an advisor can help you understand which is better for you when it comes to your financial goals.
What Is Growth Investing?
Growth investing is related to growth stocks. A growth stock is "a share in a company anticipated to grow at a rate significantly above the average growth for the market."
- The traditional definition of growth investments: A company whose earnings are expected to grow at an above-average rate relative to the market. From an identification standpoint, growth stocks are considered 50% of the equity universe with the lowest book-to-market (BtM) ratios.
- The academic view of growth investments: Earnings are a poor predictor of stock price performance over extended periods.
Investors in growth stocks anticipate earning money through capital gains when they eventually sell their shares in the future because these stocks generally do not pay dividends. This is because the issuers of growth stocks are usually companies that want to reinvest any earnings they accrue to accelerate growth in the short term.
Growth Investing Examples
Many behemoth-sized U.S. companies have long been considered growth stocks. Following is a list of the highest-ranking companies based on market cap (as of October 2022):
- Apple Inc. (AAPL)
- Microsoft Corp. (MSFT)
- Alphabet Inc. (GOOG)
- Amazon.com, Inc. (AMZN)
In 2021, Amazon made it to the top as one of the largest companies in the world. Although it now ranks fourth in the U.S., Amazon has a history of trading at a high price-to-earnings ratio (P/E). For example, the P/E ranged from about 58 to 106 between June 2020 and September 2021 but is expected to grow over 67.4 earnings per share (EPS).
As a stock analysis tool, P/E indicates how much investors will pay to receive $1 of a company's earnings. Investors are more inclined to invest in companies that are expected to grow, even with a high P/E ratio.
The risk with growth stocks is that a company may not grow as anticipated, which can cause a dramatic drop in a growth stock's price.
What Is Value Investing?
Similarly, value investing is based on value stocks. A value stock is where "shares of a company that appears to trade at a lower price relative to its fundamentals, such as dividends, earnings, or sales, making it appealing to value investors." This supposed undervaluation at purchase leads investors to expect the mto produce higher returns over time in comparison to the investment.
- The traditional definition of value investments: A company whose stock trades for less than its intrinsic value and has been undervalued by the market. From an identification standpoint, value stocks are considered 50% of the equity universe with the highest book-to-market (BtM) ratios.
- The academic view of value investments: Determining a company's intrinsic value is, at best, a guessing game. Instead, value stocks generally trade at low prices because they are out of favor with the market.
Value Investing Examples
Value stocks are typically represented by money center banks, which are large banks located in economic hubs that mainly serve other banks, corporations, and governments. The following top-ranked U.S. commercial banks are listed based on consolidated assets (as of June 2022):
- JP Morgan Chase & Co. (JPM)
- Bank of America Corporation (BAC)
- Citigroup Inc. (C)
- Wells Fargo & Company (WFC)
Investors evaluate P/E ratios when considering value stocks as well. For example, Citigroup has a P/E ratio of 6.19 (as of October 2022) compared to 19.12 for the average S&P 500 company.
As an investor, you can add value stocks to your portfolio through exchange-traded funds (ETFs). Many EFTs follow the price and performance of U.S. large-cap value stocks, including the largest value ETFs.
What Are the Differences Between Growth and Value Investing?
While growth and value investing approaches are very similar, the main difference lies in how investors view a stock's potential.
|
Basis |
Growth Investing |
Value Investing |
|
Approach |
Growth Stocks |
Undervalued Stocks |
|
Type of Co. |
Mostly Small-Cap and Mid-Cap |
Mostly Large-Cap and Mid-Cap |
|
Expense |
More Expensive |
Less Expensive |
|
Risk |
Riskier |
Less Risky |
|
Horizon |
Usually Longer |
Usually Shorter |
|
Earnings |
Usually More |
Usually Less |
|
Dividend |
Received Sometimes |
Received Most of The Time |
|
P/E Ratio |
High |
Low |
|
P/B Ratio |
High |
Low |
When comparing the difference between growth and value investing, you may hear investors discuss their horizon. Horizon generally refers to the length of time someone is willing to hold onto the stock or portfolio in order to see a return.
Which One Is Right for You? An Advisor Can Help.
When digging in on your investment strategy, do not lose sight of the forest through the trees. Debating the merit of individual stocks can be distracting when diversification in your portfolio is always crucial to investment success.
You have plenty of opportunities to research your options and take a do-it-yourself (DIY) approach to investing. However, here are a few reasons to consider the benefits of hiring an advisor:
- You lack a background in investing and sufficient experience. You could make poor decisions that could cost you in the long run.
- You don't have time to make managing your investments a part-time job.
- You prefer the peace of mind of knowing you have a professional to help guide you.
An advisor will explain the importance of portfolio diversification and help you achieve it. They’ll also help you maintain consistent exposures over time, as prices and securities tend to flip between growth and value investments.
Finally, by incorporating academic research into your investment portfolio an advisor will give your investments the best chance to meet your long-term financial goals.
You have to ask yourself what the best use of your time is. It can be helpful to consider your investment in an advisor as a way to spend less time worrying about money and more time living the life you're trying to build.
Plancorp helps investors who have outgrown basic advice or have maxed out their ability to DIY by offering investment strategy as part of a more comprehensive Wealth Management service incorporating tax strategy, estate planning and more under your financial plan.
Discover how to pursue a better investment experience by downloading our free guide today!
